Question

Describe the mechanism of impact of monetary policy on aggregate demand of the economy through interest rates?

Answer 1

Higher monetary policy rate increases interest rate in the banking system which increases the cost of borrowing and reduces aggregate demand.

Step-by-step explanation:

An increase in the monetary policy rate (mpr) will lead to an increase in the interest rates in the banking system. This increases the cost of borrowing which reduces aggregate demand. However, if the central bank reduces mpr, interest rates in the banking system reduces which leads to the fall in the cost of borrowing which increases aggregate demand.